How does market fail
Market failure occurs when the free market system fails to efficiently allocate resources and produce outcomes that are optimal for society. There are various reasons why market failure can occur:
1. Externalities: This occurs when the actions of a buyer or seller have an impact on a third party who is not involved in the transaction. Positive externalities, like vaccinations or education, benefit society, but are often under-supplied by the market. Negative externalities, like pollution or noise, harm society and are often over-supplied by the market. In both cases, the market fails to accurately account for these external effects.
2. Public goods: Public goods are non-excludable and non-rivalrous, meaning that once provided to one person, it is available to everyone and one person's use does not diminish its availability to others. Markets tend to under-supply public goods because individuals can enjoy the benefits without paying for them, leading to a free-rider problem.
3. Information asymmetry: This occurs when there is an imbalance of information between buyers and sellers. For example, in situations where sellers possess more information about the quality or characteristics of a product than buyers, the market may fail to produce an efficient outcome. This can result in adverse selection or the market providing products of lower quality than what consumers expect.
4. Market power: Market power exists when a firm has the ability to influence prices and output, giving them control over market conditions. Monopolies or oligopolies can abuse their market power by charging higher prices and limiting production, resulting in inefficient outcomes and reduced consumer welfare.
Addressing market failure often requires government intervention or regulation. For example, governments may impose taxes or subsidies to correct for externalities, provide public goods directly, enforce disclosure requirements to mitigate information asymmetry, or regulate monopolies to prevent abuse of market power.